Jul 17, 2023 - Economy

The stock market’s up big this year — but not because of earnings growth

Data: FactSet; Chart: Axios Visuals
Data: FactSet; Chart: Axios Visuals

Earnings season kicked off Friday — but investors haven't seemed to care much about corporate fundamentals lately.

The big picture: The S&P 500 is up big this year. But importantly, it's not really because people think corporations will bag far fatter profits in the immediate future.

  • In fact, Wall Street analysts think companies in the S&P 500 will see earnings per share rise just 1% in 2023, compared with 2022.
  • The S&P 500, on the other hand, is up 17%.
  • In other words, share prices are outpacing puny expectations for profit growth.

💭 Matt's thought bubble: Stock market stories often tell you flat out that share prices reflect future expectations for corporate earnings.

  • Kind of. But the markets have many moods. There are often stretches when investors are indifferent to "financial fundamentals."
  • In such times, the market's speculative pulse — animal spirits, if you like — are rising, and bullish sentiment rules.
  • At times like these — the late 1990s for instance, or even 2021 — well-reasoned arguments about profits, losses and sales are beside the point.

Between the lines: These moments often coincide with times when monetary policy is "easy," meaning interest rates are low.

  • To be clear, the Fed shows no signs of cutting rates.
  • But with inflation finally in retreat, the market is breathing a huge sigh of relief that last year's rate surge is over.
  • And interest-rate sensitive growth stocks — embodied by the Nasdaq Composite — have romped higher by more than 35% this year.

Be smart: Wall Street has jargon for everything, including the current market climate, i.e. when stocks are rising but expectations for profits aren't.

  • The fancypants term of art to know is "multiple expansion."
  • The "multiple" in question is the so-called price-to-earnings ratio, which is one of the most widely watched metrics on stock market valuation.
  • The P/E multiple is pretty high right now, at 19.5, as a result of this year's rally.
  • Historically a P/E multiple of around 15 is considered "fairly valued."

What it means: When markets peeps talk about "multiple expansion," it's basically a sophisticated sounding way of saying "the market is going up but not because companies are expected to do much better, but just kind of, well, because it's going up."

Data: FactSet; Chart: Axios Visuals
Data: FactSet; Chart: Axios Visuals

What they're saying: References to multiple expansion have multiplied.

  • "Multiples have carried the market higher since the October 2022 lows. Can investors continue to rely on multiple expansion to lift stocks? In not, earnings growth better kick in," Piper Sandler analysts noted last week.
  • "Lower inflation lowers the risk of higher interest rates, which in turn supports the multiple expansion that has boosted U.S. equities year-to-date," Janus Henderson investment analysts wrote last week.
  • "With year-to-date returns driven nearly 100 percent by multiple expansion, the market either doesn't appear to care about earnings, or it expects a major reacceleration in growth both later this year and next," wrote Morgan Stanley's stock market wags.

The bottom line: Expectations that corporate America will massively grow its profits — which are already historically giant — are not what's lifting stocks this year.

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